JPMorgan's head of US equities on the dollar, market volatility, and where investors should put their money in 2017

Tina Wadhwa

Feb. 10, 2017, 11:49 AM

Business Insider recently caught up with Dubravko Lakos-Bujas, the head of US Equity Strategy at JPMorgan.

In the interview, Lakos-Bujas discusses dollar strength, market volatility and where investors should put their money in 2017.

This interview has been edited for clarity and length.

Tina Wadhwa: So, first, just a broad question. What are the big themes of the moment on your mind? What are you worried about, what are you excited about?

Dubravko Lakos-Bujas: I would say dollar strength and the dollar strengthening further. And some of that could come on the back of current corporate tax reform proposals like the border tax adjustments that could impact the dollar upwards. So dollar strength is clearly one key source of risk for equities.

The second one is interest rates, basically higher rates that result in further tightening.

Wadhwa: Stocks on the whole have been rallying to all time highs since the news of Trump’s election. Have markets failed to price in the policy uncertainty of a Trump presidency? Are we starting to price it in now?

Lakos-Bujas: So first of all we generally see the proposals that have been suggested by the new administration, looking at them based on all the information we have available right now, as a net net positive. As sort of pro-growth.

Clearly we had a very early call on that, and we basically came out with with a tactical S&P price target of 2300 that we thought we were going to reach in early 2017. We came out with that the day after the US election. That’s the more immediate effect that we thought could take place as the market starts to price in some of these proposals and a more pro-business agenda.

There’s a lot of uncertainty so it’s hard to quantify things that precisely, but generally our view is net net constructive and we have reached this first leg up on the market. It took place relatively quickly pricing in some of these things in anticipation. What I think you’ll likely see now in the coming months is some elevated degree of volatility and elevated degree of dispersion across stocks and across industries as the market basically starts to gradually digest a lot of the views coming out. I would say in the coming months you’ll see a lot of potential volatility, and later in the year, some further small upside, so our 2017 price target is 2400.

Wadhwa: Given the uncertainty you speak of, how can investors protect themselves?

Lakos-Bujas: That’s not an easy one. You have two sides of it. One — you get a 5% pull back in the market, just given that generally fundamentals are relatively okay. Profit cycles are normalizing. Many people might use that weakness in the market to step in and buy at a cheaper level. There’s no simple way of answering that. You could look at ways of hedging your portfolio by buying volatility, buying volatility insurance, buying insurance by being long volatility, in case you do start to see some disruption or risk factors kicking in, be it on the US side with respect to these proposals or be it on the foreign side as far as geopolitics and elections. We’re going to see elections in France, Germany, the Netherlands. There’s a lot of unknowns. The second thing is if you believe that a strong dollar and rising rates are going to continue tightening conditions, don’t be surprised if at some point the Fed turns marginally more dovish, which means that gold and gold miners might be an interesting hedge to an existing portfolio.

Wadhwa: President Trump is known for his impulsive tweets, on everything from particular companies to particular people. How does an investor handle this? Are we just one tweetstorm away from a crash?

Lakos-Bujas: You have to keep in mind that if you look at the events of 2016, a lot happened. If anything, at the end of the day, the fear factor may have been elevated, but markets turned out to be fairly resilient. There was some volatility but the volatility in many cases was fairly short lived and net net the markets were fairly resilient. I think these tweets could create some degree of noise or volatility, but I think the markets adapt and eventually cut through the noise. The more you see this happen, I think the more that the markets will basically adjust. I don’t think the markets will be all over the place on the back on that.

Wadhwa: What makes the market so resilient?

Lakos-Bujas: Because I think for one you do see an environment when central bankers globally remain very cautious. Even though the Fed is looking to normalize policy, still you could say that policy is relatively accommodative and that provides some form of synthetic floor. In the fundamental backdrop in terms of earnings and the profit cycle, things in general are improving and they’re normalizing. I wouldn’t call them very strong, but they’re okay. So if you look at our expectation for this year in terms of earnings, we’re calling for 7 - 8% upside in terms of earnings delivery.

Wadhwa: Dating back to 1910,history shows that after a two term government has changed and a new government comes in, regardless of which side of the house they’re from, there’s a strong chance of a recession within 12 months. Are we headed for a recession in 2017?

Lakos-Bujas: I don’t have a strong view on that. I’ve looked at the history, I’ve looked at previous election cycles, Republican versus Democratic party, incumbent versus non incumbent etc., and from all of the in depth analysis that we do, and we find the relationship to be statistically very weak. So I have a very hard time deriving judgment on the back of that information. I think we have a fairly unique environment today and you need to look at it in full context. It’s hard to sort of make a broad brushed historical comparison there.

Wadhwa: In your view, what’s the the biggest risk to the global economy?

Lakos-Bujas: One is the dollar. The dollar continues to strengthen. The dollar on a global trade weighted basis has increased by about 20-25% over the course of the last 2-3 years. If that trend persists, you could see the global economy getting further pressurized. Keep in mind that 60% give or take of the global economy directly or indirectly is linked to the dollar. The dollar plays a very important role. That’s one key risk to look at.

The second risk is what happens with rates. There’s a good amount of leverage in the system, especially if you look at corporates. US corporates ex-financials — leverage there is pretty much in line with all time highs, back to the 2007 levels. There’s less room for tolerating a significant amount of rate increases.

And we need to see what happens on the trade side. If the US does adopt significant changes on the border side and that ends up resulting in significant retaliatory effects from some of our biggest trading partners like China, that clearly can affect the global economy.

Lakos-Bujas: Our research department’s outlook for China is still basically calling for positive growth, pretty much in line with what we saw for last year. Generally I think the macroeconomic momentum and data coming out of China and more broadly EM over the last 3-6 months has been positive. The trend has generally been positive there. So I think the outlook for us is on the positive side.

Wadhwa: Turning back to equities, what sectors do you recommend? What sectors should we stay out of?

Lakos-Bujas: Within equities, we have been early on the reflation trade. We went overweight energy in December 2015. We went overweight materials in January 2016 and we also entered the financials trade in late 2015 which may have been a little bit too early, but so far it’s been paying off. Those are our three higher conviction sector overweights that I do think have more room to run, especially financials. The fourth one I would add into that bucket is healthcare. I like healthcare. I do see healthcare as a sector that will likely continue to print superior growth. Valuations have come down quite a lot. Valuation wise it’s attractive. Headline risk isn’t going to go away necessarily given the new administration, but I think a lot of the negativity around headline risk is already priced in.

Wadhwa: 2016 saw a massive flow of funds from active into passive management, but many analysts see an upside for active investing in 2017. What’s your view? Is this trend likely to reverse?

Lakos-Bujas: We’ve published a lot on this topic and clearly you have seen this big trend and rotation from the fundamental active equity world into the passive equity world. There are multiple reasons behind this. 2016 was the worst rotation from active to passive at least in the last 10 years, if not longer.

The drivers behind this are twofold. You have cyclical drivers and structural drivers. Structural drivers won’t necessarily go away anytime soon. Structural drivers include everything from technological advancement to significant increases in computing power. Passive products have benefitted from these trends, and we have seen a proliferation of quant type products, smart beta, low vol, which are more passive in nature. They tend to give the end client more transparency and more liquidity. There's also been a huge focus on fees. I don't think those structural drivers go away anytime soon. They continue to persist. And the move flows underneath from active into passive.

The cyclical drivers could be the growth environment and the interest rate environment. The outlook is somewhat more constructive going forward, and if we expect the dispersion will generally likely pick up given all of these moving variables on the policy side and on the macro side, that should bode well for your fundamental active manager. From a cyclical point of view, as you go into 2017, maybe 2018, I think there are going to be some positives. But I think these positives continue to get pressurized by some these negative structural effects.

So I would say I’m not so sure that you will now see a complete reversal in this rotation, but I think you’ll see a slowdown in this rotation from active into passive.

Wadhwa: What are your views on the way Brexit is unfolding and on the upcoming European elections? What are you worried about and what do you see as the biggest risks?

Lakos-Bujas: I think it's still very unclear what a Brexit means in terms of outright trade. How does trade get renegotiated? Is there basically a hard stop or is there some kind of middle ground? It’s very hard to say. Clearly some degree of negativity has already been priced in, but then again I think we’re sort of in a wait and see mode to see what exactly takes place there. Plus Brexit could take awhile to play out — it could take years. I think the more imminent risk are the elections in the Eurozone area — Netherlands, France, Germany. Brexit and the US election do provide a reference point and at least some precedent of what could happen with these upcoming European elections. So is there a possibility of a tail risk event there? Clearly there is. I don’t think we should be underestimating that. But I think our base case remains one where net net you will see a relatively balanced outcome. Could you see periods where volatility sort of spikes all of a sudden and you get these sort of fat tail risks play out? You could, but our net net case is that the underlying fundamentals and the macro backdrop will continue to gradually improve and that will be the more important factor. Momentum will likely continue to stay positive.